How to start a startup

Do you have an idea for the next big thing? If so, you’re already well on your way to starting a startup.

But a brilliant idea is just the beginning. There are infinite factors to consider when starting a company, from developing your business idea to building your team to establishing your business. It’s a long, complicated road ahead. To keep it simple, we’ve boiled it down to some of the main categories with guides, templates, and tools to help you at every step. 

Building your founding team

Surround yourself with a team of experts you trust to help you grow your budding business, including co-founders, lawyers, and advisors.

Co-founders

Having a co-founder means sharing responsibility, so you’re not totally on your own. Choose a partner who has complementary skills or knowledge to your own. Most importantly, find someone who will share your vision for the company. 

Keep in mind that you and your co-founder(s) will need to make some early decisions about how to split up ownership of the company. While this step might not seem urgent when your company is little more than an idea, this decision will have important implications down the line, especially if your company achieves success.

→ Tool: Model founder equity percentages with Carta’s co-founder equity split tool

Lawyers

Selecting a team of lawyers or a law firm is on par with choosing your co-founder. Most founding teams will have to start thinking of their legal needs once they’re ready to accept a check from investors. Having the right legal team to assist you through the process of forming and financing your company can make a big difference in your ownership and control of the company going forward.

→ Guide: Learn how to find the right lawyer for your startup

Advisors

Startup advisors can offer valuable advice when your company is young, but many startups (especially pre-seed, idea-stage ones) don’t have much cash on hand to compensate them. Giving advisors a percentage of your company in the form of advisory shares allows you to reward the people who help your company grow with ownership and “skin in the game.” 

→ Guide: Learn more about how advisory shares work

Establishing your startup

It goes without saying that setting up your business as a legal entity and registering it with a state is important. While colloquially called “ incorporation,” formation is the official term for making things official. 

Deciding when to incorporate and how to incorporate your business can have huge implications down the road. From understanding tax implications (more on that later) to properly setting yourself up for future investment and growth, there’s a lot riding on your choice.

Choosing a business structure

Most founders must decide between a limited liability company (LLC) or a corporation entity type. Each has its pros and cons, depending on what kind of company you’re building. 

Corporations

Common types of corporations include C-corporations (C-corps) and S-corporations (S-corps), which have the same underlying legal entity type but are taxed differently. When you form an entity, you’ll have to pay fees to set it up, file a Certificate of Incorporation, comply with all regulatory and tax requirements, and file other various reports.

A corporation is best for companies looking to raise funding from venture capitalists (VCs) or institutional investors in the near future. Those sources of capital will almost always require incorporation as a C-corp.

LLCs

A limited liability company (LLC) is a business structure that legally separates business assets from your personal assets. This structure protects owners from being pursued personally for repayment of debt or liability associated with their businesses. 

If your business doesn’t need VC or institutional investment, then an LLC offers protection from personal liability and additional options for tax structuring—while also being more flexible to manage.

→ Tool: Determine which business structure is right for your company

Startup equity management

Holding equity means you have an ownership stake in the business. A wide range of people and entities can own equity in a company, including the company’s founders, investors, employees, advisors, and consultants. Organizing a capitalization table, or “cap table,” is the first step to getting ahead of equity management.

Cap table

A cap table is a document, like a spreadsheet or a table, that details who has ownership in a company. It lists all the securities or number of shares of a company including stock, convertible notes, warrants, and equity ownership grants. As you can imagine, tracking ownership in an Excel spreadsheet gets complicated as your company grows. Equity management software like Carta’s grows with you.

→ Download: Cap table template

Creating a stock option plan

Having an official stock option plan is a key step before you can prepare to issue equity to your company’s employees, advisors, and shareholders.

There are several regulations that you need to follow in order to stay compliant when granting equity—including (among other things) corporate approvals and state securities filings.

While you should always consult with your legal team to tailor your stock option plan to the specifics of your business, we created some example stock option plan templates to get you started with three essential documents every stock option plan should have:

1. Form of option agreement

2. Form of exercise agreement

3. Equity incentive plan

→ Download: Example stock option plan templates

Issuing shares

How you issue company shares depends on the chosen business structure ( LLC vs. C-corp), along with a few other factors.

Equity for corporations

There are several different types of equity for corporations, including stock options and equity awards. 

Equity for LLCs

LLCs have several different equity incentive  plan options available, including: 

1. Profits interests units (PIUs)

2. Membership interests units

3. Phantom equity

4. Options to acquire LLC interests 

→ Tool: For hands-on help choosing an equity plan for your LLC, check out Carta’s LLC Blueprints.

Accounting

Recording equity grants on your company’s income statement is important, especially as it grows. ASC 718 is the standard accounting method used to expense options. Companies generally get audited for the first time while raising a Series A or B round of funding, but possibly earlier depending on the size of the round.

Creating an option pool

An option pool, sometimes called an employee stock option pool, is a block of shares set aside to be issued as future equity in the company. An option pool is not only for employees; it houses future equity you can issue to advisors and other service providers. 

→ Tool: Model the value of your employee stock option pool using Carta’s option pool calculator

Valuing your company

To manage your company’s equity and keep track of what shares are worth for each holder, it’s essential to know the valuation of your company, which is an assessment of the worth of a company at a given time. You can measure the valuation in several ways. 

409A valuations & fair market value

A 409A valuation is an independent appraisal of the fair market value (FMV) of a private company’s common stock (the underlying security reserved mainly for founders and employees, but not investors) on the date of issuance. In order to offer or issue equity to service providers, understanding the FMV is crucial unless you want to risk severe IRS penalties for the company and equity holders.

→ Download: 409A sample report

Pre-money valuation

A pre-money valuation is based on the  terms of a deal being offered by an investor, and states the value of your company not including the investment amount itself. It helps determine the ownership stake that investors will receive in exchange for investing in your startup.

Post-money valuation

A post-money valuation is the value of your company after it has received a round of funding, and it is also based on an investor’s deal terms. It is calculated by adding the new investment value to the pre-money valuation of the company.

Preferred price

Preferred price is the price-per-share for preferred stock issued by your company to investors. The price of preferred stock is typically higher than the price of common stock, which is usually held by founders and employees.

Internal rate of return (IRR)

IRR is a method VCs and other investors use to track the performance of private company investments before other profitability metrics are available. The internal rate of return shows the annualized percent return an investor’s portfolio company or fund has earned (or expects to earn). 

→ Tool: Internal rate of return calculator

Startup fundraising

Rounds of fundraising follow certain naming conventions: “Pre-seed” comes before “ seed,” which comes before “ Series A,” which is followed by series B, and then down the alphabet. These stages also functionally describe how mature the company is and can give investors an idea about how much financial risk they’d be taking on. 

As an early-stage startup founder, it’s normal to want to accept funding wherever you can find it. The true value of an investment, however, often comes from your relationships with the investors you choose to work with. 

The partners you bring into your business, and the tenor of the relationships you build with them, are often more important than the “name recognition” of the venture capital firms they work for.

Types of investors

Common sources of startup financing include:

• Angel investors: An angel investor is someone who uses their own money to invest in a private company.

• Venture capitalists (VCs): Investors who pool outside capital and combine it with their own money to invest in early-stage companies are called venture capitalists.

• Accelerators and incubators: Accelerators and incubators are programs that guide, mentor, and help fundraise for startups in exchange for an equity stake in the company.

• Bootstrapping: Bootstrapping is the process of using personal finances, revenue, and free or low-cost resources to build a business without outside investment.

→ Guide: Types of startup investors

Working with your investors

An investor update is detailed information about your company’s financials, key hires, and customer wins. Sending investor updates at regular intervals is a way to build trust and confidence with your backers as your company grows. 

Term sheets are typically used by lead investors to express their initial interest in your company during a priced round. They are preliminary, non-binding documents that are followed up with a formal agreement if the deal moves forward. Term sheets may be used during a seed round, but they are more common at the Series A round and beyond. 

→ Download: Investor updates template

Fundraising options

Most companies raise funds every 15–18 months, hoping to raise enough capital for a 12–14 month cash runway. Your funding options will vary depending on which stage your company is in. 

Typical fundraising options for founders include:

• Seed fundraising: Also called seed funding, this is the preliminary capital, most often from VCs or angels, which helps launch a business or develop a prototype or minimum viable product (MVP). 

• Priced round: When a startup is raising a round of financing at a specific valuation, it’s known as a priced round. In other words, priced rounds are equity investments based on a negotiated valuation of a company.

• Convertible securities: A type of investment that lets founders raise money while postponing negotiations on the company’s valuation until a later time. Convertible notes and SAFEs are the two most common types of convertible instruments.

→ Tool: SAFEs and convertible notes calculator

Alternative fundraising options

There are multiple ways to fund your company. Some less common, but often equally effective, funding options are:

• Tranche financing: A type of financing in which investors release funds in parts as your company hits certain milestones instead of providing one lump sum.

• Venture debt: A bank loan for companies between venture capital funding rounds with less associated dilution for shareholders.

• Equity crowdfunding: The process of collecting small contributions from a large number of people, typically online. Some equity crowdfunding websites specialize in fundraising for businesses and can get the pitch out to a large group of general investors ( unaccredited investors included).

• Other loans: Some companies might qualify for small business loans with a longer payoff period.

• Down round: A down round is when a company raises a VC financing round and the pre-money valuation of the company is lower than the post-money valuation of the previous round. 

• Bridge rounds: A bridge round is extra money a company raises between priced rounds that helps founders extend their last round of fundraising. 

→ Tool: Cash burn rate calculator

Pitching investors

A pitch deck is a presentation that a founder or executive uses to tell investors about their company during the company’s fundraising process. It can be the foundation of an in-person fundraising presentation, or can be shared on its own as a written document. 

A pitch deck typically includes information about the company and its leadership, the market opportunity it is targeting, and the company’s revenue and business models. See examples of Carta’s pitch decks for our Series A and Series D rounds. 

→ Guide: Prepare for your next meeting with investors using our pitch deck guide

Hiring a team

Compensation is what you pay employees in exchange for their time, work, or services. Getting comp wrong or failing to properly invest in your employees can be the difference between a thriving company and a failed startup. 

Here are some of the steps founders can follow to create a compensation plan:

• Develop your company’s compensation philosophy

• Define roles and levels ( job architecture)

• Create performance management guidelines

• Consider incentives including bonuses and equity compensation

• Determine first hires ( and what you’ll pay them)

Hiring employees overseas adds an additional layer of complexity. Companies must familiarize themselves with regional labor regulations and customs, as well as salary levels, in order to make effective job offers.  

→ Guide: How to create a job leveling framework

Startup taxes

Taxes are never simple, but they become exponentially more complicated when you’re growing a new startup. Founders have several key tax considerations to keep in mind.

Federal, local, & payroll taxes

Taxes are one of life’s only certainties. So it should come as no surprise you’ll face federal- and state-level taxes as a startup founder. Depending on the state in which you’re incorporated or in which you conduct business, you may also owe city- or county-level business taxes.

After you hire your first employee, your company is required to withhold and pay Social Security, Medicare, and other payroll taxes too.

Entity structure

Whether your company is a corporation or an LLC will affect its tax liability.

LLC taxes

LLCs can “pass-through” taxes to members, meaning any profits or losses aren’t recognized by the LLC itself, but rather by all LLC members on their individual tax returns. 

Most LLCs must prepare an annual tax document called a “ Schedule K-1,” which outlines each member’s income, losses, deductions, and credits for the tax year.

→ Guide: How taxes work for LLCs

Corporation taxes

Corporations including C-corps may be subject to “double taxation.” That means the corporation itself pays taxes on its profits and, usually, ‌distributions to shareholders are also subject to taxes.

→Guide: Learn more about business tax deadlines for LLCs and corporations

Equity compensation taxes

Issuing equity comes with various tax implications for your company and for your employees, depending on the type of reward. Tax treatment for stock options (ISOs or NSOs) is different than tax treatment for RSUs or RSAs. 

Educating your employees about the tax liabilities of their equity should be a priority for any company. Not only does equity education help your employees, but the last thing any founder has time for are endless questions about taxes. 

→ Guide: Learn how taxes work for ISOs and NSOs

QSBS

If your startup qualifies as a small business (according to the IRS’s rules for eligibility), then it’s possible your employees and other equity recipients can take advantage of the qualified small business stock (QSBS) exclusion. QSBS status offers a 0% capital gains tax rate for federal purposes, up to a cap.

Deductions & credits

Startups may be able to take advantage of certain tax credits and deductions, which can lower your company’s tax liability. To maximize your startup’s tax benefits and ensure your business is compliant with state and federal tax codes, we strongly recommend working with a tax professional or accountant.

Exit strategies

An exit event is most startup founders’ pot of gold at the end of the rainbow and is traditionally a celebratory occasion. Typically an IPO or M&A gives existing shareholders the chance to access liquidity and potentially realize on-paper gains by selling some or all of their shares.

IPO

An initial public offering (IPO) or “going public” is when a company begins trading its shares on a stock exchange for the first time. IPOs allow a company to raise capital in the public market by selling newly issued shares and allowing its existing shareholders to sell their shares. Usually, an IPO is the first opportunity for the general public to buy a stake in a high-growth tech startup.

→ Checklist: IPO Readiness Guide & Checklist

M&A

M&A stands for “mergers and acquisitions” and is used colloquially to describe transactions where one company (the buyer) purchases all or a portion of another company (the target). Buyouts, consolidations, acqui-hires, or restructurings are all terms that you may have heard that fall under the broader umbrella concept of M&A. 

Keep in mind, exit events still require some heavy lifting. ​​A Purchase Price Allocation (PPA), for example, is frequently required for tax and financial reporting following a merger or acquisition. 

→ Download: The ultimate guide to M&A transactions

As always, consult your startup’s lawyer or tax advisor at every stage–even if the finish line is right around the corner. At Carta, we help startups grow. Learn why over 35,000 startups use Carta for cap table management, equity advisory, valuations, and more.

FAQs

What is a startup?

A startup is any new business that’s in its early stages of operations and fundraising. Startups can be in any sector, including technology, healthcare, and agriculture. Startups are private companies that are not publicly traded. When a company has an exit event like an IPO or M&A, it is no longer considered a “startup.”

What is an entrepreneur?

An entrepreneur is an innovator who brings a new idea, skill, or product to market. Entrepreneurs start a new business by absorbing a high risk for the chance of a high reward. 

What free startup resources are available for entrepreneurs?

Entrepreneurs can take advantage of several free resources, including mentorship, startup accelerators, and online resources. Carta provides infrastructure for innovators to grow. Learn more about our free resources for founders by visiting the Carta Classroom or signing up for the Founder Studio. 

Can you start a startup with no experience?

Lack of experience shouldn’t stop you from sharing your next great idea with the world. Many successful startup founders have little or no experience in their new chosen industry. Free resources, a strong network, and grit can help supplement a lack of experience.

How much money do you need to launch a startup?

From bootstrapping to angel investors, VCs to priced rounds, there are no rules for how much money you need to launch a startup. You can launch a startup with a few thousand dollars or millions of dollars, depending on the type of business, location, or industry.

How do I start a startup team with no money?

Prior to fundraising, you can start your team by leveraging your network or offering equity compensation in exchange for peoples’ time, money, or advice. 

What should I do if I have no idea how to start a startup?

Not sure where to start? Access free articles and video lessons exclusively for founders in the Carta Classroom.

What is the best way to find a co-founder?

To find a co-founder, leverage your personal and professional network, attend local events for startup founders, or get free advice tailored for your company in Carta’s Founder Studio.

How do you know if your startup idea is good?

Testing the market is the best way to see if your idea will be successful. You can do this by seeking help from friends and family, other founders and entrepreneurs, or conducting market research. Entrepreneurs often launch initial versions of their products or services into the market in a limited way. This allows them to gather data on how the product is being used and how they may improve it to gain more users.

Why is it so hard to start a business?

Starting a business from scratch requires a high level of commitment from founders, as well as time and money. And unfortunately, even businesses with sufficient funds fail. Timing and luck play a role too—some ideas are excellent, but may not catch on with customers for a variety of reasons. Competition in your industry, the overall financial market, and other unpredictable hurdles add to the complexity of starting a business. 

What percentage of startups fail?

We’ve all heard the stats around the difficulty of building a startup. Depending on your source of information, it’s been estimated that between seven to nine out of every 10 startups fail. Determining true failure rates is a difficult exercise. 

At Carta, we use our data to determine the overall State of Private Markets.